Financial markets position for interest rate hikes

March 24, 2010   by PLANT STAFF

LÉVIS, Que.: Although world economies are experiencing a timid recovery, North America is showing surprising growth and financial markets in some countries are now focusing on interest rates, according to a Desjardins Group economic study (Economic and Financial Outlook Spring 2010).

“The financial markets have done well in absorbing the recent debt crisis in some countries and are now focusing on the upcoming interest rate increases,” said François Dupuis, the Levis, Que.-based financial group’s vice-president and chief economist.
 And unlike the US where inventory change played a big role in economic growth by the end of 2009, the Desjardins Group said Canada is benefiting from fairly robust domestic demand, fuelled by rising employment.

Only foreign trade will be a drag on the pace of growth, hurt by imports that continue to rise more quickly than exports, said Yves St-Maurice, director and deputy chief economist.

“Canada’s strong financial institutions, a real estate market that is not too far out of balance, and governments that made the right decisions at the right time are now encouraging the Canadian economy to get back to a more normal situation.”


The Desjardins economists forecast GDP growth of 3% in 2010 and 2.9% in 2011.

In Quebec, Desjardins believes tight fiscal and budgetary policy from the government will temper an upswing in Quebec’s consumer demand and the real estate market. It’s forecasting a real GDP of 2.4% in 2010 and 2.6% in 2011.

Ontario and BC are expected to lead the provinces with real GDP increases of 3.3% per cent. The real estate market’s strong recovery will stimulate housing construction in Ontario, while the automobile sector will gain strength. Bolstered by its hosting of the Winter Olympics Games, BC will also see its real estate market make a strong comeback.

Alberta and Newfoundland and Labrador will benefit from rising oil prices with renewed investment in the industry, posting increases of 2.8% and 3% in 2010.

The Atlantic provinces will post the worst performance, with 2.2% growth next year. The situation will be quite different in 2011 when all the Canadian provinces, except for BC and Ontario, will record stronger growth.

Although global economic performance will be uneven, real GDP will reverse from a contraction of 1.4% in 2009 to an increase of 3.7% in 2010 and 3.8% in 2011. As a result, the Desjardins economists believe commodity prices will remain firm, even if the supply is big enough to meet the increased demand. They forecast oil prices to end 2010 at around US$90, and then pass US$100 in 2011.

Desjardins forecasts a rate hike of 25 basis points in July, which will be repeated in subsequent intervals, with the rate cresting at 2.5% in the second half of 2011.

Like Europe and the UK, the US will not be strong enough to cope with rate hikes in 2010, so short-term rate spreads between Canada and the US will increase, putting pressure on the exchange rate. Desjardins said the loonie should hit parity very shortly, slowly rising to US$1.04 in the fall of 2011.

“The exchange rate’s volatility and potential impact on foreign trade could, however, become a concern for the Bank of Canada, prompting it to rethink the sequence of forecast key interest rate increases,” said St-Maurice.